Planning strategies for your business and you

Now is the time to think about 2019 tax planning — before you find yourself in a year-end scramble.

“Business owners have a better sense of what kind of year they are having, and how that may impact their tax bill. They still have time to act,” says Jane Pfeifer, CPA, Shareholder at Clark Schaefer Hackett.

Smart Business spoke with Pfeifer about how taxpayers can plan ahead to fully utilize beneficial tax options.

How did the finalized Tax Cuts and Jobs Act (TCJA) regulations and most recent IRS notifications impact planning?

Under the TCJA, the Section 199A business income deduction was created, allowing taxpayers who own interests in pass-through entities to take a 20 percent deduction of qualified business income earned in a qualified trade or business. Taxpayers need to know where they fall under the clarified regulations. The deduction does not apply to attorneys, accountants, doctors or dentists, and certain other professional service providers whose income is above $350,000 for married filing joint taxpayers or $157,500 for those filing as single taxpayers.

The TCJA made changes to Section 163(j) regarding limitations on interest deductions, which can have a significant impact on a taxpayer’s 2019 tax bill. This is another area where regulations were delayed.

If a company’s gross receipts are above $25 million, deductions for interest expense are limited to 30 percent of taxable income from the business, before depreciation, amortization and interest expense. If an entity has a loss for the year, its interest deduction may be limited. Or, if a business is highly leveraged, it may not get that full deduction if gross receipts are above the limit. Also, the gross receipts of all related entities may need to be considered.

How can depreciation help business owners?

To reduce income taxes, a business owner may want to purchase and place new fixed assets in service by the end of the year. Under Section 179, entities can elect to expense up to $1 million of qualifying property, which includes HVAC equipment, fire protection or security systems. This break is phased out for qualifying purchases over $2.5 million. In addition, 100 percent bonus depreciation is still in play for 2019.

While these deductions do not apply to real estate purchases, a cost segregation study divides a building into components, where some might qualify for accelerated depreciation. For instance, special wiring or adaptations required to run equipment can be reclassified to a shorter depreciable life.

Many states, however, disallow the aggressive depreciation deductions that are available on a federal level.

What changed for individual returns?

The standard deduction increased. For 2019, it is $12,200 for individuals and $24,400 for joint filers. Therefore, taxpayers may want to take the standard deduction one year and itemize the next. This can be done by accelerating 2020 charitable donations into 2019. Individuals may be able to do the same thing with medical expenses if these expenses exceed the adjusted gross income threshold.

Many people under-withheld in 2018. While taxpayers should have addressed this early in 2019, there is still time to mitigate under-withholding.The IRS requires a minimum withholding of 22 percent for special compensation like restricted stock or bonuses. Depending on a person’s overall tax bracket, the minimum is often not enough. Looking at this now may avoid an unpleasant surprise in April 2020.

What else should taxpayers keep in mind?

Individuals need to understand their capital loss carryforwards and investment portfolio. Should taxpayers offload underperforming stocks to generate a loss at the end of 2019 and offset gains? Could sales that generate gains be offset by loss carryforwards?

Taxpayers also should consider maximizing retirement and health saving account (HSA) deferrals. Individuals 49 and younger can defer up to $19,000 in a 401(k) plan; 50 or over can contribute up to $25,000. HSA contributions max out at $7,000 for family plans or $3,500 for individual plans. Taxpayers who are 55 or older can contribute an extra $1,000. If medical expenses such as braces, glasses, hearing aids, etc., are on the horizon, funding an HSA is like getting a tax deduction by moving money from one pocket to the other.

Insights Accounting is brought to you by Clark Schaefer Hackett

Quality of earnings: a unique perspective on a business

In a market in which deal valuations have reached a high-water mark, many owners are exploring a possible sale of their business. Those who are ready to take the next step should first think about how their business will look to potential buyers through the lens of a quality of earnings report.

“A quality of earnings report is typically ordered after a letter of intent as part of the financial due diligence,” says Thomas G. Wolf, CPA, a senior manager at Brady Ware & Company. “It’s important in negotiating and structuring a deal as it determines what may or may not be sustainable in terms of revenue and profits.”

Smart Business spoke with Wolf about quality of earnings reports, how they differ from audited financial statements and how they can be used outside of deal negotiations.

What is a quality of earnings report, and how does it differ from audited financial statements?

A quality of earnings report typically comes about as part of a transaction that’s being negotiated and is ordered by the buyer, seller or someone interested in investing in the business. The report aims to identify financial performance factors that aren’t reflected in the business’s financial statements, whether those are internal statements or audited financial statements, to determine the company’s normalized performance and sustainability.

Audited financial statements look to determine if transactions happened in accordance with GAAP. In performing an audit, CPAs look backward at what has happened and how it was reported.

A quality of earnings report looks forward. It seeks to identify sustainable revenues — those that are repeatable — and eliminate anomalies — anything outside the control of the company, such as broad economic factors, that won’t have an ongoing impact on the company’s financial performance. These reports can assess whether revenues are part of a smart management decision, or the lucky swing of a market force.

How long might this report take to produce, and what information is needed to create it?

It takes 30 to 45 days to produce a quality of earnings report, and it’s based on any and all financial information that would typically be part of an audit, such as transaction history, financial statements, customer and vendor contracts, employment agreements, a market analysis and any other information that may be relevant to the business. But the assembly of a quality of earnings report is more fluid than an audit. To understand how a revenue stream works, the report’s creator will follow any important information to its source — if a business says it’s got great vendor contracts, then evidence of that should be provided.

Owners will want to purify their financial statements ahead of a quality of earnings report. That means getting rid of any personal assets or expenditures that are on the company’s books. That will give the parties an accurate snapshot of the business and its performance at the due diligence stage.

Who should companies work with to get a quality of earnings report?

Typically, CPA firms are used because quality of earnings reports have financial information as the starting point, then dive deeper. There are specialized firms that will put together these reports. Private equity firms might have internal experts who can produce these reports, but sometimes that can present a conflict of interest. CPA firms, on the other hand, are necessarily independent of a transaction, and that objectivity lends more weight to the report for both sides.

How can a quality of earnings report be used to improve a company and its internal processes?

Not every deal goes through. Things can fall apart for any number of reasons. If that happens, the owner has a window to use the report to find aspects of the business that could be tightened up. This could include market risks that could be mitigated, vendor contracts that could be improved, etc. Just as a buyer could take the report and find potential pitfalls, the seller can do the same, using the report to make the company better and more attractive to buyers.

Insights Accounting is brought to you by Brady Ware & Company

Growth is great, but only if you’re prepared

Businesses that are growing — whether it be in volume or in new ways like creating a new product or pursuing a new market — are in fact setting themselves up for failure if their systems do not keep up. If your business’s operating system — how work is done — is outdated, growth slows and internal frustration rises.  

“An unreliable system means a company’s sales team, rather than growing the business, spends its time apologizing to clients because the organization cannot deliver,” says Ray Attiyah, author of “Run Improve Grow” and chief innovation officer at Clark Schaefer Hackett. “It creates conflict and turnover because employees feel ineffective as they struggle to realize success.”

Smart Business spoke with Attiyah about a leadership system that prepares companies to achieve their future goals by creating a properly designed operating system to accommodate growth. 

When a company’s systems, processes and standards fail to deliver, what is the impact?

New or rapid growth frequently exerts pressure on existing systems, and the more a company grows, the more difficult it becomes for employees to reliably meet increased demands. 

As a reaction to poor performance, managers may blame the frontline team for failures. Their haphazard problem assessment leads to poorly prescribed solutions such as ‘hold people accountable.’ They fail to assess whether workers have the appropriate tools to effectively do their jobs. Rather than engaging the workforce to listen to the symptoms and methodically define root causes for the failures, assigning blame is often demoralizing and creates fear of repercussions.

Other times, senior leaders question whether middle managers have the right skill set to lead critical improvements. Focusing on individual performers rather than all contributing variables can lead to multiple negative outcomes, including management turnover, a lack of confidence to pursue growth and an inability to meet increased business demands, or unprofitable growth (because resources are used inefficiently). This cycle is very tough on an organization.  

What is Run Improve Grow?

When a company pursues new growth, including new products, services, customers or sectors, it requires an operating system capable of reliably executing. And that is where Run Improve Grow (RIG) can help. 

RIG is a leadership system that focuses on where your people are spending most of their time. Are your frontline leaders empowered to effectively run the daily operations of your business? (RUN) Are your managers working on process improvements (IMPROVE), and are your executives working on the future of the business (GROW)?

With RIG, you empower your frontline workforce — the people responsible for making the products or delivering services — to be effective problem solvers capable of eliminating chronic pinch points that create daily frustrations.

How does Run Improve Grow differ from Lean or other forms of Continuous Improvement?

Lean is a method of gaining efficiency through waste elimination. RIG gives you the framework to develop a robust new system, rather than making patchwork changes to an existing system. RIG sees the waste in the management activities — not just in the workflow. Your employees are given the tools and authority to take action, enabling them to achieve results quickly.

How can organizations empower frontline employees and unlock everyone’s potential?

Empowerment occurs when employees have the authority, systems, standards and tools to succeed. There is nothing you can’t do when you have the confidence and internal support to do your job with conviction.

By applying the fundamental rules of RIG, your frontline leaders will clearly understand their role and be empowered to run the daily operations of your business without inhibitions. RIG creates a fearless and engaging culture that improves employee retention, which in turn attracts new talent, making recruitment easier.

With your employees operating at peak performance, management and your executive team are empowered to focus on process improvement, growth and innovation.

Insights Accounting is brought to you by Clark Schaefer Hackett

How the new lease rules may affect your balance sheet

The Financial Accounting Standard Board’s (FASB’s) new lease accounting rules are having a significant impact.

Historically, U.S. accounting standards classified leases as operating or capital, but the criteria for differentiating between the two has not been consistently applied. This inconsistent application has made it difficult for end users to compare financial statements. Now, nearly all leases must be reported on the balance sheet as a liability and a corresponding asset or a right-of-use asset.

“This could impact more than just leases and will have ripple effects throughout organizations,” says Brad Eberhard, principal at Clark Schaefer Hackett. “For instance, people are looking at their service contracts to see if the contracts need to be considered under these new lease standards.”

“An IT service contract that identifies a server, for example, could fall under the new standard and need to be included on a balance sheet,” says Michael Borowitz, shareholder at Clark Schaefer Hackett.

Smart Business spoke with Eberhard and Borowitz about the changes to lease accounting and their impact on organizations.

Why was the change made?

The FASB sought to add consistency among reporting entities. It also moves U.S. accounting standards toward international standards, which adds increased uniformity.

End users felt financial statements were not always comparable and understandable, due to the subjective nature of applying the lease standards. The old lease standard essentially allowed companies to maintain a liability off the balance sheet, based on their interpretation of whether the lease was capital or operating. A company with a leased piece of equipment has received a service and has an obligation to pay, which is the definition of a liability. FASB concluded this as well and sought to move these ‘off balance sheet’ liabilities to the balance sheet.

When do companies need to be compliant?

Public companies have to comply with the new standard for periods beginning after Dec. 15, 2018, which impacts their current financial reporting. Private companies’ effective date starts with fiscal periods beginning after Dec. 15, 2019.

The 2018 filings of large public companies can guide private companies, but private companies should determine now how this new lease standard fits into their operations. The biggest implementation burden will fall on companies with a large number of leases, including larger retailers that lease locations, businesses with leased machinery and vehicles, or companies with significant service agreements. Businesses must evaluate each lease agreement to determine the lease value and record the value on the balance sheet. Additionally, all future leases will need to be evaluated. Even with these complexities, implementation is solvable.

Do you expect the lease standard to change how companies operate?

As leases are renegotiated, terms may be shorter. A 10-year lease might convert to a five-year lease with a five-year renewal option. That places a smaller liability on the books by calculating net present value based upon five years. However, the standards require the lessee to consider all renewal periods in the net present value calculations that are reasonably certain of exercise.

Also, there could be instances where rather than attaching service agreements to a specified piece of equipment, they will describe general equipment usage.

What else do employers need to know?

Software can assist with the complexities of leasing operations and the required calculations. Private employers, however, may not yet realize how deep this could go because they have not thoroughly reviewed all of their contract agreements yet.

With the help of their accountants, employers need to track down leases and service agreements and begin to understand whether they are being reported correctly. They should stay tuned as amendments and technical corrections are issued.

Companies need to start educating internal financial departments, as well as others who deal with contracts, like operations managers and sales representatives. As new leases are signed, business leaders should consider the effect on future financial reporting. Also, it’s important to determine how balance sheet changes will affect bank covenants as additional debt is added to the books.

Insights Accounting is brought to you by Clark Schaefer Hackett

Leases take a spot on the balance sheet with new accounting standards

Changes to the financial reporting of leases by the Financial Accounting Standards Board (FASB) is a decision that is more than 10 years in the making. The new standards require businesses to record all leasing arrangements on their balance sheets while also better aligning U.S. and international financial reporting standards. 

Public companies, some nonprofits and some employee benefit plans with annual periods beginning after Dec. 15, 2018, have already begun implementing the changes. All other calendar-year entities will need to adopt the new rules for annual periods beginning after Dec. 15, 2019. Doing so is not just a matter for accounting departments. These changes could potentially trigger loan covenants or otherwise make it necessary to revisit existing banking agreements, as the underlying basis for these financial relationships are likely to be impacted.  

Smart Business spoke with Eric J. Schnieber, a shareholder at Clark Schaefer Hackett, about the changes to the financial reporting of leases and what companies need to know about their impact.

What are the new standards and how do they differ from the previous standards? 

Under the old rules, capital leases, recognized as a form of term financing, hit balance sheets as both an asset and liability. Operating leases, which generally represented a stream of rent payments with no transfer of ownership, were only required to be disclosed in financial statement footnotes, a practice commonly referred to as off balance sheet financing. These inconsistencies created heartburn for many users of financial statements.  

Under the new standards, all leases will need to be recorded as a right-of-use asset with an offsetting liability on a company’s balance sheet. And that is a big change.

What will be the effect of these changes?

There is very real concern by some companies that these newly reported liabilities could have a significant impact on their financial statements (hundreds of thousands or even millions of dollars). Changes that significant will alter the complexion of a lot of balance sheets, which will impact the way banks and other financial institutions look at the debt profile and overall financial risk of a company. 

It is not all negative, though. The new standards are more consistent with those of foreign company financial disclosures. That could put U.S. companies seeking foreign direct investment in a better position to access new capital markets because foreign investors are more comfortable with the clarity the new standards offer. 

What should CEOs understand about the effect of these changes? 

CEOs should concern themselves with understanding what new liabilities will appear on their companies’ balance sheets. There is a chance that the changes could impact debt covenants, in which case a conversation will need to be had with the bank about amending those agreements so the company’s access to capital is not negatively affected.

There is also the chance that a company’s increase in liabilities could substantially affect its debt-to-equity ratio or fixed-charge coverage ratio, and that also may impact a company’s access to capital, or at least drive up the interest rate that is being applied. 

How can CEOs mitigate the impact the changes will have on their companies?

Companies that are reliant on leasing should prepare to talk with their banker(s) and other stakeholders by first having a conversation with their accountant. Accountants have significant knowledge on the topic and can help companies create a strategy before conversations with lenders are had. 

An accountant will help a company develop an analysis of its financial position given the standards changes and make clear the expected year-to-year effect the changes will have on the company’s balance sheet. From there, the company and its bank can discuss how those changes will affect the banking relationship and negotiate a plan. 

Time is running out, so start the implementation process now. Waiting until December 2019 could prove costly to companies from a financing perspective and would likely cause significant delays in financial reporting. 

Insights Accounting is brought to you by Clark Schaefer Hackett

What business owners should be thinking about ahead of an exit

The choice between the sale or succession of a business comes down to the philosophy of the owner. Some owners want their company to have a next chapter, others might want to cash out and get the most money they can from a sale, and others want to see their business stay in the family and be carried on by the next generation.

Once the philosophy is determined, then an owner has to follow through by investing in a management team, prepping the business for a sale and taking it out to market, or grooming a family member to run the business, all of which require time and a plan.

But selling a business isn’t just a financial transaction. It also ushers in a major lifestyle change, which is something not every business owner considers as they consider their exit strategy.

“Owners who sell and retire with no plan for how they’ll spend their time inevitably run into trouble,” says Sam Agresti, director of Brady Ware & Company.

Smart Business spoke with Agresti about how business owners should prepare their business and themselves for an exit.

When should business owners start planning for an exit from their business?

Ideally, business owners want to cultivate a culture of transition, which is a perpetual undertaking and involves consistently moving people up through the system via career paths wherever possible. Those who have only recently come to the idea of exiting their business need to begin honing a plan over the course of three to five years before its execution. To do it in less time is possible, but it will likely have a negative impact on the business’s value.

How should business owners prepare the next generation for succession?

Business owners should focus on housekeeping. Review how the entity is structured and all of the outstanding contracts and ensure that everything is documented correctly. Also review any employee agreements, such as contracts and noncompete agreements, that exist to make sure key employees will stay with the business where possible post sale.

Owners should take a hard look at what they’re paying themselves and how that affects the books. Get the company’s financials cleaned up in that regard so that an audit will produce a three- to five-year history that reflects the true operational costs of that company. It’s best to get certified statements because the better quality the financial statements are, the more the owner gets out of the business.

What needs to be done to prepare a business for a sale?

Preparing the business for a sale is similar to preparing the business for succession. The main difference is that when an owner is selling the business, there’s more of a short-term horizon on any capital expenditures. Decision-making is also more focused on the short-term. That means not investing in a new machine or computer system upgrade, because that investment will outlast the owner’s targeted exit date. Rather, try to drive bottom-line growth with each decision.

Also, take a look at the facility itself and do whatever work is required to affordably get the structure and the grounds looking as presentable as possible.

What considerations should business owners make regarding their post-exit lives?

Owners typically put a lot of thought into the financial aspects of post-exit life, making sure they’ll have enough money to afford the life they want in retirement. But many don’t think through what exactly they’re going to do day in and day out, and that’s important, because former owners will suddenly have a lot of time on their hands. It’s something owners should consider as they form their exit plan.

Who should business owners work with to prepare themselves and their business for an exit?

Put an advisory group together that consists of an attorney, accountant, financial planner and a business consultant who specializes in exits. A consultant will help owners prepare for an exit not just financially, but by helping them determine what their future looks like when they’re no longer running a business. Look for consultants who see the transaction as much from a human perspective as they do a legal or financial perspective.

Insights Accounting is brought to you by Brady Ware & Company

Cyber fraud: The biggest threat to your organization is you

When it comes to ransomware and other cyber threats, the leading risk comes from your employees. If they either don’t care or haven’t been trained to understand when an email link is suspect or a request for information requires a phone call first, your organization may join the growing ranks of financial fraud victims.

“It can happen to anybody. It can happen to any size company and any type of organization,” says Reggie Novak, CPA, CFE, senior manager at Ciuni & Panichi.

Everyone needs to be asking: What can I do? What types of controls do I need to help mitigate and deter fraud?

Smart Business spoke with Novak about cyber and financial fraud threats.

What are common types of cyber fraud to guard against?

Ransomware is a type of malicious software that infects and restricts access to a computer until a ransom is paid. Although there are other methods of delivery, ransomware is frequently delivered through phishing emails and exploits unpatched vulnerabilities in software or lack of knowledge from the organization’s employees.

Phishing emails are crafted to appear as though they’ve been sent from a legitimate organization or known individual. These emails often entice users to click on a link or open an attachment containing malicious code. After the code is run, your computer may become infected with malware.

That’s why training is critical, along with adequate password controls, up-to-date software and antivirus programs. While smaller organizations, nonprofits and governmental entities may not have the resources for segregated duties or the most up-to-date accounting programs, they can still educate staff and mitigate the risk.

How should organizations secure their operations?

Establish security practices and policies to protect sensitive information. Make sure employees know how to handle and protect personally identifiable information and other sensitive data. Clearly outline the consequences of violating these policies.

Educate employees about cyber-threats and hold them accountable. Also educate your employees about how to protect your business’s data, including safe use of social networking sites.

Protect against viruses, spyware and other malicious code. Ensure each computer is equipped with antivirus software and antispyware, which is readily available online. Since vendors provide patches and updates to correct security problems and improve functionality, configure all software to install updates automatically.

Secure your networks and internet connection with a firewall and encryption. Protect your Wi-Fi network. Set up your wireless access point or router so it doesn’t broadcast the network name, known as the Service Set Identifier or SSID. Also, password protect access to the router. If employees work from home, ensure their home system(s) are protected by a firewall.

Require employees to use strong passwords and change them often. Consider implementing multifactor authentication that requires additional information to gain entry. Check with your vendors that handle sensitive data, especially financial institutions, to see if they offer multifactor authentication.

Employ best practices on payment cards. Work with your banks or card processors to ensure the most trusted and validated tools and anti-fraud services are used. Isolate payment systems from less secure programs. Don’t use the same computer to process payments and surf the internet.

Make backup copies of important business data and information. Back up data automatically, or at least weekly, and store this offsite or on the cloud. This can cut down on your ransomware risk especially.

Control physical access to computers and network components. Prevent access or use of computers by unauthorized individuals. Laptops are easy targets; lock them up when unattended. Create a separate account for each employee with strong passwords. Administrative privileges should only be given to a few people.

Create a mobile device action plan, especially when these devices hold confidential information or can access the corporate network. Require users to password protect their devices, encrypt data and install security apps for when the phone is on public networks. Set reporting procedures for lost or stolen equipment.

Insights Accounting is brought to you by Ciuni & Panichi, Inc.

Untangling tax reform for domestic corporations with foreign subsidiaries

One goal of the Tax Cuts and Jobs Act (TCJA) was to end the lockout effect and encourage U.S. companies to bring back cash held by foreign subsidiaries. It also sought to make the U.S. more tax competitive, so fewer U.S. businesses would move offshore.

“So far, some of the tax system’s new provisions and revisions have had a dramatic impact on domestic corporations with foreign subsidiaries,” says Joseph Calianno, partner and international technical tax practice leader at BDO USA LLP.

Smart Business spoke with Calianno about the tax environment for domestic corporations with foreign subsidiaries.

Which provisions are impacting domestic corporations with foreign subsidiaries?

First, the Internal Revenue Code (IRC) requires U.S. shareholders of certain foreign subsidiaries to pay a one-time transition tax (Section 965) on untaxed earnings, even if those earnings are still offshore.

The act also modified existing rules. The controlled foreign corporation (CFC) anti-deferral rules tax income even if the earnings aren’t repatriated. Going forward, the amount of CFC earnings taxed offshore has significantly expanded under IRC Section 951A, also called Global Intangible Low Taxed Income (GILTI). The rules for determining the GILTI inclusion are complex and require detailed calculations.

However, domestic C corporations (C-corps) may be able to take a new 50 percent deduction on GILTI amounts, subject to special rules and a taxable income limitation. With the reduced corporate tax rate, the GILTI inclusion for C-corps generally would be taxed at a 10.5 percent rate, assuming the full IRC Section 250 deduction applies. C-corps also may be eligible for a foreign tax credit relating to the GILTI inclusion, subject to certain limitations.

Moreover, the TCJA added IRC Section 245A, a 100 percent dividends received deduction (DRD). This participation exemption enables some C-corps that satisfy certain requirements to receive dividends from foreign subsidiaries without being taxed under certain conditions.

How does the TCJA target U.S. base erosion?

With the lower corporate tax rate of 21 percent, the government wanted to prevent base erosion. A new provision, IRC Section 163(j), limits business interest deductions, while the base erosion and anti-abuse tax (BEAT), under IRC Section 59A, imposes an additional corporate-level tax on certain corporations. BEAT is fairly complex but, in essence, it targets corporations making payments to foreign-related parties that reduce the U.S. tax base, when they meet a gross receipts and base erosion percentage threshold.

IRC Section 267A deals with deductions for related-party interest or royalties with hybrid instruments or entities. At a high level, this provision is designed to prevent one party from obtaining a deduction in its jurisdiction, when the other party in its jurisdiction doesn’t include a corresponding amount into income.

What are corporations doing now?

Planning is at the forefront given all of changes to the tax system. These provisions can change behavior to some degree, e.g., how much debt a corporation will incur can be influenced by the ability to deduct the interest. Guidance from the IRS and Department of the Treasury, mostly in the form of proposed regulations, provides greater certainty as to how a provision may operate or how a provision should be interpreted. Corporations are evaluating the impact on their organizational structure and transactions, and considering if they want to restructure or change how they do business.

Do you think tax reform will result in more corporations repatriating cash?

Generally, yes. Many foreign subsidiaries have previously taxed earnings, as a result of the transition tax or CFC anti-deferral rules, that, largely, may be repatriated without additional U.S. tax. This assumes there is sufficient cash in the foreign subsidiary to be repatriated — earnings don’t necessarily equate to cash. Further, the 100 percent DRD can help facilitate repatriation.

However, whether a corporation brings cash home can depend on the need for the cash in the U.S., the need for cash in the foreign jurisdiction for the foreign business, foreign restrictions on the repatriation of cash and foreign withholding taxes.

Insights Accounting is brought to you by BDO USA, LLP

Sales and use tax laws are complex. Here’s how to minimize the risk.

Staying current on sales and use taxes is difficult, as state revenue needs, technology and social attitudes change.

“Sales and use tax laws are complicated. For example, Ohio taxes over 20 categories of services, and several different types of services can fit within each category. Also, the state has over 100 sales tax exemptions, depending on how you count them,” says Stephen Estelle, Tax Manager at Clark Schaefer Hackett. “Then compound that by the laws of each of the 45 states that levy a sales and use tax, which are equally as complex. And no two states are the same.”

Smart Business spoke with Estelle about how to manage sales and use tax compliance.

Why are sales and use tax laws so complex?

Sales and use tax laws balance state revenue needs with economic and social policy. This balance changes as the economy fluctuates, as states need more money or as social attitudes shift, and every state draws different conclusions about what should or should not be taxed.

Technology is also advancing rapidly. When state laws do not change to keep up, tax departments must fit new products and services into old statutory language. This can get confusing. For instance, is cloud computing a good or a service? Where is it located, and which state gets to tax it?

Another factor is the changing intersection between state law and the federal constitution. For example, the U.S. Supreme Court’s recent decision in South Dakota v. Wayfair Inc. held that a business’s physical presence is no longer required for the state to compel the business to collect the state’s use tax. Rather, a business’s economic presence is sufficient. Most states now use a specific number of transactions and/or amount of sales to determine when a remote seller is economically present, but the thresholds can differ from state to state.

What can happen when businesses are non-compliant with these taxes?

State tax departments can conduct sales and use tax audits, just as they conduct income tax audits. If they determine a business has not collected sales tax or self-reported use tax, states can charge interest on the uncollected or unpaid tax and impose penalties.

Penalties vary by state. If a business fails to collect and remit Ohio sales tax, for instance, the civil penalty can be up to 50 percent of the tax. If the business collects Ohio sales tax and keeps it, in addition to a 50 percent civil penalty, the business could be subject to criminal penalties. The person at the business responsible for collecting and remitting tax could also face civil and criminal penalties. If a company is not collecting or remitting sales tax, the statute of limitations in Ohio is 10 years. With use tax, Ohio can go back seven years.

How can business executives minimize their risk of under or over payment?

The first step is education. Business leaders should not start selling into a state, even if it is in the home state of their business, without clearly understanding how the sales tax or use tax laws apply.

With respect to sales tax, complex businesses should consider purchasing sales tax automation software. After the initial set-up, the software automatically incorporates changes in the law. If new products or services are added to the business, they must be integrated into the software.

If a company cannot afford tax automation software, a less expensive approach is to have a tax consultant prepare a cheat sheet that describes when collecting taxes is necessary and when it is not. This information should be updated annually, as well as when business operations change.

On the use tax side, every business should know when vendors should charge tax, as well as which exemptions apply to the business or industry. Each state has different exemptions. When a business expands into a new state, it is necessary to consider these state-by-state tax variations. Using a consultant to navigate these differences can be helpful. For example, accounts payable employees can refer to a summary prepared by the consultant when monitoring vendor invoices. Remember, vendors might also be confused regarding tax requirements.

Because sales or use tax is likely a small amount on each invoice, it may not be top of mind until a business receives an audit letter. A tax consultant can provide critical advice whether the business is handling compliance correctly to avoid future surprises.

Insights Accounting is brought to you by Clark Schaefer Hackett

Weighing the options for implementing the new revenue recognition

As private companies apply the new revenue recognition standard, they have two options for reconciling their 2019 financial statements with those from 2018, which was under the old guidance.

“We told our clients to keep detailed records, so it would be easier to bring the two systems together,” says George Pickard, principal of the Audit and Accounting Service Department at Ciuni & Panichi Inc.

However, no matter how prepared, it’s still burdensome to change how you recognize revenue when you enter into contracts with customers to provide goods or services. That’s why standard setters allow organizations to either retrospectively restate 2018 financial statements or follow a cumulative approach.

Smart Business spoke with Pickard about the benefits to each method, where to get additional implementation help and the need to educate financial statement users.

How should a private company decide which method to follow?

One option is to restate your 2018 financial statements and make changes to your income statement, as if the new revenue recognition standard was in place. Practical expedients to make this easier, include:

  • Completed contracts that began and ended in the same annual reporting period do not need to be restated.
  • For completed contracts with variable consideration, the transaction price at the date of completion may be used, rather than estimating the amounts.
  • The disclosure of outstanding performance obligations and how much revenue is tied to those can be skipped.
  • Retrospective restatement of the contract is not required for contracts that are already modified.

The other option is to cumulatively apply the standard. You keep your 2018 numbers, but you still adjust your beginning equity for 2019. Then, you disclose which line items of 2019 have been affected by the new standard and what they would have looked like under the old guidance.

The decision between the two needs to be taken on a case-by-case basis. Restating makes it easier for financial statement users to look for trends, but it may be time consuming and burdensome. If, for example, you’re planning to sell your company in the near future, the ability to have multiyear comparisons that give a clear picture may be worth the effort. On the other hand, if you have a lot of contracts that are now completed and it will be very difficult go back and get all of the necessary details, the cumulative method may be better.

What assistance is available for implementing the new standard?

Beyond working with your accountant, the American Institute of Certified Public Accountants (AICPA) has come out with audit guides specific to revenue recognition. It also put together task forces that looked at 16 industries and implemented the new standard, giving detailed examples of how to carry out this revenue recognition. If your organization falls under aerospace and defense, airlines, asset management, broker-dealers, construction contractors, depository institutions, gaming, health care, hospitality, insurance, not-for-profit, oil and gas, power and utility, software, telecommunications or timeshares, you should look at these.

The AICPA also is coming out soon with a revenue recognition tool kit.

Why is it critical to educate users of your financial reporting about what to expect?

If banks, stakeholders or shareholders use your financial statements because they loaned you money, you don’t want them to be caught off guard, especially when agreements incorporate covenants. If revenue is recognized earlier or later than it used to be, you may fail a covenant under the new standard.

In addition, some bonus compensation and other agreements with employees are tied to revenue. The new standard may change the timing of revenue reporting, which could change whether people hit a goal. It may be a case of rewriting the agreement or a having conversation upfront with your employees.

The more communication that gets out, the less stakeholders, banks, employees or other users of financial statements will be surprised. You need to share what they should expect to see for the 2019 period, and if you’re issuing interim statements, you’ll want to have those conversations a lot sooner.

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